Why the Online Prediction Markets Blew New Hampshire

Hillary Clinton's shocking victory in New Hampshire spattered egg
all over the faces of Beltway wonks and pollsters. And they
aren't the only ones. The prediction markets got it wrong
too.

Intrade, perhaps the most well-known of the political bourses,
put Obama's chance of victory at about 70% before the results
started coming in. At 8:30 pm, as the Concord Monitor released
early returns indicating a better than expected Clinton turnout,
Obama's chances dropped to 56%. At no point did Intrade seem to
be leading publicly available information. The price simply
reflected an amalgam of polling data and the collective group
think of overrated "experts."

And guess what? In this respect, Intrade and its competitors
differ little from financial markets.

Predicting how people will vote is even trickier than predicting
what and how much they'll buy or what they'll be willing to pay
for stocks. There are comfortable quantitative fundamentals in
the world of finance; there's guidance, there's supply and demand
and rational expectations. Although stock market predictions are
far from scientific, people buy more rationally and predictably
than they vote, where the picture can be clouded by the most
subtle and unpredictable of psychological nuances.

In denouncing prediction markets as "wrong," however, many
pundits miss the point. Prediction markets do not provide
accurate predictions of the future. (How could they? They simply
represent the consensus guess of a group of people who aren't
prophets). They merely provide the most-informed guess as to what
that future is likely to be.

As numerous "collective wisdom" studies have shown, the consensus
guess is always better than the majority of the individual
guesses that are factored into it (not sometimes--always). The
collective wisdom, moreover, is often more accurate than that of
ANY individual. Why? Because the market collectively incorporates
far more information than is available to any one
individual.

Like the stock market, prediction markets don't get it right
every time. They do, however, provide a useful window into the
collective expectations of others--one that is often the best
available estimate of the future. And they do sometimes get it
right. Just as they did with Mr. McCain.